July 30, 2014
A Short Feeder Cattle game plan…
Buy the November 222 Feeder Cattle Put, currently trading at about 5.75 cents or $2875 + 61 = $2936…or about $3000.
This option expires the same day as the November future on November 21st, or 114 days from now.
If we get to expiration, and this option is losing money, or in fact has become worthless, it will only mean that Feeder Cattle are still around, or above, the 222 level. In other words, no sell off has occurred…yet.
If this is the case, your next act will be to buy another put, using an at-the-money April 2015 Feeder Cattle Put, most likely paying another 6 cents ($3000) for essentially the same option you owned in November, meaning you would then have about $6000 in the trade.
This may mean you are buy 222 puts, or 232’s or 242’s…There is obviously no way to know where it will be, but again, if your original 222 put has lost money, it will mean this contract is still SKY HIGH. And as we “know” (nothing is “known” in this business), at some point it goes the other way, and my supposition is it will do so in typical futures market fashion, which implies at least a 25-30% decline in prices.
Beyond that, IF we get to April and this market has yet to sell off (which, to me, is virtually impossible but anything can happen), you do it again.
Aside from those steps, I’d add the
following alternative: If the market has not collapsed by the time the November
puts expire, it probably would make sense to double the position size (yes,
doubling down) and buy two puts for every one you originally owned, meaning each
“unit” would now represent a $9000 investment ($3000 + $6000).
If you have the funds to risk, I will tell you that spending the money is actually the easy part…The toughest thing will be to let the trade keep working once that top tick has been made…to not see the market drop 15 cents and think, “Got to grab that profit”. I mean it when I say, “Forget you own it”. In fact, I would suggest that your best approach would be to plan on keeping the option all the way to expiration. This is a cash settlement option, meaning you don’t have to get out of it. Whatever it’s worth on expiration day is exactly what it’s worth, and I cannot count the futures contracts I have seen make their contract low on their last day of trading.
As I’ve told a few of you, this sort of strategy can kill you if you try to use it on the buy side with a market that you believe is at an extreme low…as bottoms can sometimes take forever to form…And you could therefore be spending money every 4-5 months for a couple of years waiting for the turn to be made. But I believe tops are inherently different, that they generally don’t take that long to form, and there IS a point at which, A MARKET THAT HAS BEEN A ROCKET JUST CAN’T GO ANY HIGHER…AND THE NEXT STAGE IS PRETTY MUCH EXACTLY THE SAME AS WHEN AN ACTUAL ROCKET DOES RUN OUT OF FUEL…IT FALLS STRAIGHT DOWN…WHICH IS PRECISELY WHAT I AM LOOKING FOR HERE.
I may be dead, dead wrong, and if I am, it will certainly mean losing money…but I DO THINK AT LEAST A 25% DECLINE IS IMMINENT AND INEVITABLE IN FEEDER CATTLE, and the REAL truth is, I think we are going to see something even bigger than that.
Here are a few more numbers…
15% from current levels takes this market to about 190, at which point the option is worth 32 cents or $16,000.
20% from current levels takes this market to about 179, at which point the option is worth 43 cents or $21,500.
25% from current levels takes this market to about 168, at which point the option is worth 56 cents or $28,000.
And those numbers are why I have become fully committed to being in this trade. Yes, those look like big bucks but the numbers are real…They are not exaggerated. In my mind, this IS going to happen…And making it work is just a matter of taking measured, reasonable financial steps to be in the market...and stay in the market, and then, being able to LET IT HAPPEN when the decline does get started.
The Cattle Complex has become highly volatile and highly emotional during the past few weeks, both of which can be indicative of tops, and I’m getting this out today as my gut instincts tell me this thing is THERE. I can’t imagine who would be/could be left on the short side…and THAT is the when the end always seems to come.
I bought this very same option for my big sister today and our game plan is exactly what I have outlined above. Here’s hoping she brings us luck.
Call me. Thanks.
The author of this piece currently trades for his own account and has financial interest in the following derivative products mentioned within: Feeder Cattle